Analysis

K E Y N O T E

I N T E R V I E W

Seizing the moment

PAG’s Chris Gradel considers the expanding opportunities
for private real estate debt in APAC
Non-bank lenders are well-positioned
to emerge as crucial players in financing real estate in the Asia-Pacific region, as they capitalize on the confluence of economic growth, regulatorychanges and, more recently, spiking
interest rates. Chris Gradel, chief executive and co-founder of APAC-focusedalternative investment firm PAG, says
now is the time to take advantage of anattractive risk-reward profile.

QNon-bank lenders aregaining traction in AsiaPacific. What factors are driving
the growth of the real estatedebt market in the region?

There are really three factors, one ofwhich is the macro situation. Asia-Pacific accounts for 40 percent of global
GDP and has accounted for about 50
percent of global GDP growth over the20 PERE

•March 2024

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PAG
past 10 years. It is a large region whichis growing fast, and the need for capitalis obviously growing as well.
Secondly, there is the global tightening of banking regulations – which,to a large extent, has really created thisprivate debt world. Since 2008, after
the global financial crisis, bank regulation has only been going in one direction, and that has created the gap for
non-bank lenders.
We are seeing that in Asia as wellas in Europe and the US. A big part ofthat is Basel III and IV, of which there
are many adopters in the region. But
local regulators have also implemented
their own restrictions on banks, which
has created a large and growing gapthat is being filled by private lenders.
And thirdly, there are cyclical factors. Outside of China and Japan, rates
have been going up, and that has increased the cost of debt. Rates goingup has also created more stress and,
whenever there is stress, the banks tend
to pull back. Relative to the US andEurope, banks account for a larger partof the credit markets in Asia-Pacific, so
any pull back is acutely felt by borrowers in the region.

Q

From a pan-Asianperspective, are private
real estate debt returns
attractive versus the risk taken?

Yes. It depends on the deal structure, ofcourse. There are good and bad deals
possible under all environments. Butoverall, we are seeing a large and growing lending gap, and not a lot of players

Analysis
who can really compete.
In our target markets, we estimate
a $20 billion-$25 billion gap, creatinga growing need for non-bank credit.
At the same time, these are markets
where you really need to have strong
local teams and good on-the-groundknowledge.
We are by most metrics the largest
private debt investor in Asia-Pacific.
We have over 100 people across 12 offices in the region sourcing, executing
and monitoring private debt opportunities locally. That scale, combinedwith the lending gap, creates an environment where we can generate an attractive risk-reward.

QHow does the risk-return
profile of real estate debt
in the region compare withcorporate debt?

There are two parts to private debt:
primary lending and distressed/specialsituations. On the distressed side, both
corporate and real estate can throw up
good opportunities. Historically, goingback to previous crises, people including ourselves made very good returns
from those opportunities. But there iscapped upside in real estate distresseddebt. And in corporate debt, traditionally there has been higher return, albeit
with higher risk.
On the lending side, it is reallyabout the size of the gap from traditional lenders and then the amount ofcapital focused on it. And there I think
the real estate opportunity is better
than corporate.
In terms of the amount of capital,
corporate private debt is far bigger
than real estate private debt. Globally, there is probably four to five times

more capital for corporate than there isfor real estate.
It is similar in Asia-Pacific, but wethink the lending gap here is larger on
the real estate side, and there are few
non-bank lenders who can compete.
So, when we look at the terms you
can get on the real estate side, they are
more attractive.
For instance, in the senior space, it
is possible to generate mid- to highteen returns. On the corporate side,
you are probably looking a few points
lower than that.

QIn Asia-Pacific, whichmarkets present
opportunities and, conversely,
which ones may posechallenges for investment?

We currently like Australia, New Zealand, Korea and India, in particular.

QHow have financing terms changed
in markets affected by rising interest
rates, such as South Korea, Australia andSingapore?

We have seen rates go up in all markets except
China and Japan – and obviously lending rates havegone up as well. But the spread is driven by thesupply of credit and the demand for that credit, andthat does vary by market.
In South Korea, rates have gone up. Historicallythere has been a lot of liquidity in this market,
which has kept spreads quite low. Traditional
lenders had really captured most of the market. But
now, with a bit more stress, we are seeing banks
being more cautious, pulling back, and we see a
bit more of a lending gap appearing. Spreads arestarting to widen to more interesting levels for us.
Australia has a good-sized lending gap. Rates
have gone up and spreads have stayed fairlyconstant. So overall, the rates you can charge havegone up.
Singapore is slightly different. There is a lotof liquidity, so rates have gone up, but spreads arevery thin because there is a lot of traditional capital
available. In Singapore, there is not really much ofan opportunity for a non-traditional lender, at leastin the senior space.

March 2024

• Asia Debt 21

Analysis

The benefit of having a pan-Asia platform is that we can pivot to different
markets depending on the opportunity
set. In India, for example, there havebeen three key changes that have recently made it much more interesting.
The first of those is the legal system.
The bankruptcy regime implemented
post-2017 has made the market muchmore creditor-friendly. The law has
teeth and has also very much changed
borrower behavior.
Secondly, there is a large lending
gap currently. India is now the fastest-growing major economy in theworld, but bank lending has been flat,
mainly because the banks are very conservative. And thirdly, we think India
has probably one of the best macro stories in the world currently.
In Japan, the cost of capital is still
very low and we are not seeing so muchstress, so there isn’t so much on the distressed side. Japan is opportunistic, asis Singapore.
In Hong Kong, there is some spillover from some of the problems inChina. There are some borrowers withissues that are creating some rescue financing type opportunities.
In China, we are playing opportunistically on the distressed side, looking
at dislocated property developer bonds
and opportunistic distressed situations.
On the primary lending side right now,the developer defaults have been sowidespread that really most borrowers
are in balance sheet repair mode andthere are very few clean assets.
And then in Southeast Asia, we aregenerally cautious, primarily because
the legal systems are a bit less creditor-friendly at this stage.

Q

When underwriting debt,
have you been morecautious on sectors like office?

Most of our activity has been on the residential side, where we feel it is easierto underwrite the asset values. We havebeen generally cautious on commercial

22 PERE•March 2024

“In the senior space, it
is possible to generate
mid- to high-teen
returns”

real estate. Having said that, there are
office markets around the region which
are pretty strong.
In Korea, for example, the Seoulmarket has slightly over 1 percent
vacancy; there is a real lack of supply. That is why I say we must takethings on a case-by-case basis. Generally, though, we have been cautious
on assets valued on a cap-rate basis– particularly office, where both rent
occupancy and rates can result in big
moves in valuations.

QHow have you seen thespace changing acrossmarket cycles?

“These are markets
where you reallyneed to have strong
local teams andgood on-the-groundknowledge”

PAG has been active since 2004 in theprivate debt space and we have invested over $40 billion in Asia-Pacific private debt. I think the biggest change
we have seen has been the regulatoryenvironment. Bank regulation has historically been good for our business,and it doesn’t look like that is going todramatically change.
Basel IV – or Basel III Endgame,as some people call it – has generated
some pushback, so we will see whether
that has much impact on slowing regulation. But even Basel III, as it stands,
created a lot of room for the private
debt business to really develop.
The competitive landscape has alsochanged. Leading up to 2008, a lot of
our strongest competitors were theprop desks at the banks, which obviously disappeared after the global financial crisis. We still see hedge funds
come in, play a bit in the private debt
space, sometimes get burned and thenexit again.
You then have global funds, especially US funds, which come andgo. But this is a market where youneed to be on the ground for the longterm, as I have said. You need to invest in the infrastructure, in the market, in the relationships to play thesemarkets properly. I think that is very
important. n